Macro 33 financial markets

Question 1

3 reasons for the large financial sector in the UK?

Answer 1

1. Skilled labour - comparitive advantage.
2. External economies of scale - technology.
3. Close to the EU - foerign labour if needed - labour intensive industry.

Question 2

Define principal of the loan?

Answer 2

Total amount you have borrrowed.

Question 3

What is the job of the banks/pension funds/stockbrockers in the fianancial market?

Answer 3

1. Take surplus funds from savers and chanel it to borrowers.
2. Provide a payment mechanism - middle man like VISA.
3. Provide expertise on investment.
4. Provide forward markets.

Question 4

define forward markets?

Answer 4

The agreement to buy/sell at a fixed price in the future.
It is used to buy or sell an asset at a pre-agreed price, but the actual exchange happens in the future. This removes risk an uncertainty.

Question 5

what is a capital market?

Answer 5

A capital market is where long-term borrowing and lending take place — typically for more than a year.

Question 6

what is a money market?

Answer 6

The money market is where short-term borrowing and lending occur — usually for less than a year.

Question 7

what is a the foreign exchange market?

Answer 7

The foreign exchange market is where currencies are bought and sold. It determines exchange rates.

Question 8

Define retail banks?

Answer 8

High street banks that lend to households, firms and let borrowers deporsit money into a savings account.

Question 9

Define investment banks?

Answer 9

Doesnt accept deposits from ordinary members of public. Trade in securities, shares, bonds, and other assets. Trades on behalf of wealthy individuals.

Question 10

Difference between investment and retail banks?

Answer 10

• Customers are other banks vs households/firms.
• Investmnet banks dont have deposit accounts and and arent involved in the housing market.

Question 11

What is a pension fund?

Answer 11

People deposit money once a month and they invest on your behalf - state assests only.

Question 12

Define hedge funds?

Answer 12

Big companies that take big risks with wealthy peoples money

Question 13

Define spot market?

Answer 13

Currencies are bought and sold for immediate delivery, at the current exchange rate.

Question 14

What are the 4 characteristics of money?

Answer 14

1. has to be portable.
2. accepted by everyone.
3. has to be scarce..
4. has to be durable.

Question 15

Define narrow money?

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Answer 15

Narrow money refers to the most liquid forms of money — money that can be used immediately for transactions. Notes and coins and bank deposits.

Question 16

What is broad money?

Answer 16

Broad money includes narrow money plus less liquid forms of money — money that can’t be used instantly. Whole sale and retail deposits.

Question 17

Define liquidity?

Answer 17

Cash or an asset that is easily converted to cash

Question 18

What does the loanable funds theory state?

Answer 18

That interest rates will be determined by the supply (savings) and demand (investment) for funds.

Question 19

Why does the demand curve slope downwards?

Answer 19

When IR are low, the cost of borrowing falls, demand fir money rises and investnment increases.

Question 20

Draw the loanabe funds theory diagram?

Answer 20

draw supply and demand. supply curve is savings and demand curve is investment. axes are interest rate and qty of money

Question 21

why are there many different interest rates in the market?

Answer 21

• Profitability
• Investments and savings.
• Borrowing demand.
• recession.
• Risk - credit ratings.

Question 22

Define balance sheet?

Answer 22

Shows the assests and liabilities of a business.

Question 23

Define asset?

Answer 23

Something a business owns - item

Question 24

Define liability?

Answer 24

Something that you owe.

Question 25

Define liquidity crisis?

Answer 25

current liabilities > current assets

Question 26

what is the conflict between profit and liquidity?

Answer 26

liquid assets yield a lower rate of return than illiquid assets. A bank will be tempted to invest in high risk products that yield a higher return

Question 27

why are secured loans less profitable than unsecured loans?

Answer 27

secured loans have a collateral and so charge lower interest rates compared to unsecured loans.

Question 28

Explain why banks take high risk with loans and why its a problem for the govt?

Answer 28

Becuase of high returns. Problem as the government will need to bail them out if they go bankrupt.

Question 29

What did thatcher do when dergulating the financial market?

Answer 29

1. Building societies were allowed to operate as banks. 2. banks were allowed to lend out mortgages. 3. Commercial banks were now also allowed to carry out activity that were traditioanally done by investment banks.

Question 30

State the 6 market failures associated with the financial sector?

Answer 30

1. Assymetrical information 2. Externalities. 3. Moral hazard. 4. Speculation. 5. Market bubbles. 6. Market rigging.

Question 31

Explain Assymetrical information as a source of market failure?

Answer 31

Bank has better knowledge like where and when to invest. Person borrowing knows their financial position and when they can pay it back.

Question 32

Explain externalities as a source of market failure?

Answer 32

- Economic growth if people can borrow money. - Financial crisis from excessive risks. - Credit crunch. Cant borrow money. - Increased national debt. - Increased productivity from investment.

Question 33

Explain Moral hazard as a source of market failure?

Answer 33

Agents take more risks because they are insured. Banks know not to lend money, but they know that the governemnt can bail them out.

Question 34

Explain speculation as a source of market failure?

Answer 34

When someone hears about an asset price going up, thye go and buy that asset. Other people see and they also start buying. This increases demand and so price increases. Then they sell to make a profit.

Question 35

Explain Market bubbles as a source of market failure?

Answer 35

Unsustained increase in the price of an asset. Shown by a shift in demand to the right. Housing, crypto. Credit bubble (FC 2008) - When banks lend excessively to households, and that fuels a boom in consumption and private debt.

Question 36

Explain Market rigging as a source of market failure?

Answer 36

When individuals/companies exploit the market for their own good. Banks fix interest rates between each other. OR insider trading - you hear something when working in a company so you buy the stocks of it to make a profit.

Question 37

Explain "deregulation" as a cause of the financial crisis?

Answer 37

Reckless lending from banks to individuals with low credit scores. For example, peoplem with very low salaries are able to obtain mortgages that were significantly higher than their annual income. This became known as the subprime mortgage crisis. This is where banks had lots of bad mortgages on their balance sheet. They bundled these assets (mortgages) and sold them to investors. These investors realised what happened ans started selling these assets and so the price of the assets fell. Demand for housing fell, banks stopped lending so prices fell.

Question 38

Explain "loanable funds theory" as a cause of the financial crisis?

Answer 38

People saved a lot of money in countries like china, so the supply of money shifted right. IR falls and the qty of money increased. This allowed people to borrow more and exacerbated the housing bubble.

Question 39

Explai Minimum wage in the banking industry as regulation in the financial market?

Answer 39

Bankers bonuses were capped at a 100% of their salary. This way, bankers will take less risks as they know their bonus is capped. The more money they lend, the more the profit, the bigger the bonuses. So reckless spending will stop. EVAL: these have been removed because it reduces economix growth.

Question 40

Explai basic regulations as regulation in the financial market?

Answer 40

Rules on liquidity - have to hold a certain amount of cash incase people come asking for their money.

Question 41

Define central bank?

Answer 41

A public institution that is repsonsible for monetary policy, controls supply of money, inflation, managing exchange rates.

Question 42

Explain the the 4 roles of the central bank?

Answer 42

1. Implementation of monetary policy - primary objective is inflation but they also monitor economic growth. 2. Banker to the government - lend money to the government. Happens through QE. Not legally allowed but they do it anyways, 3. Banker to the banks – lender of last resort - lend money to commercial banks when they are on the brink of bankruptcy. Commercial banks can also sell their illiquid assets to them and take short term loans. They bail them out becuase one bankruptcy will lead to other bankruptcy in the banking industry. 4. Role in regulation of the banking industry - prevent financial institutions from undertaking activities which harm consumers or engage in risky activities.

Question 43

Pros and cons of the BOE being a lender of last resort?

Answer 43

+ Intervenes when neccessary - prevent collapses of the banking industry. + Easy access to quick money - during a recession. and need growth. - Moral hazard - become dependant.